INFLATIONANDINTERNATIONALTRADE.pdfVIP

INFLATION AND INTERNATIONAL TRADE James P. Houck Professor, Department of Agricultural and Applied Economics, University of Minnesota International trade and trade policy are difficult enough to under- stand when price levels remain relatively constant. But when rapid or chronic inflation are added, most of us find that whatever grip we have on economic principles begins to slip away. This is because general price inflation reflects changes in the level and distribution of real income within countries and across national boundaries. Infla- tion also tends to change currency exchange rates and international balance of payments accounts. This paper examines briefly some of the major ways in which inflation can influence trade among nations. Inflation is a sustained increase in the general price level of a national economy measured either at the retail or wholesale level. The annual rate of change in this price level, commonly expressed in index numbers, is the inflation rate. Constant Inflation Rates First imagine a curious world in which all trading nations display rapid but equal inflation rates. No changes occur anywhere in relative prices-all conceivable price and cost ratios stay constant over time. Since currency exchange rates are really price relatives, no exchange rates would change in response to this inflation. Thus, no price- induced changes in imports, exports, interest rates, capital flows, or balance of payments would occur. Such a world would be uninteresting from our point of view unless this constant international inflation rate were accompanied by un- equal rates of change in real income. These could emerge because of differential rates of growth in real output across international bor- ders. Unequal changes in real income could induce changes in com- modity trade and foreign exchange through demand shifts, but these would not be inflation phenomena as such. Now consider t